Intellectual property may be subject matter protected by copyright, patent, trademark, trade secret or right of publicity law. In the current marketplace, any business that develops a new product or service is at risk that the misappropriation or misuse of another or others intellectual property—either inadvertent or intentional—exposes the risk of infringement assertions of third-party patents when launching a new product or service. Such intellectual property may be owned by competitors, individual inventors, or patent licensing and enforcement companies (“PLECs”). Historically, the risk of intellectual property infringement claims could often be managed through cross-licensing and credible threats of countersuits. Today, however, because of the increased threat of infringement assertions by individual inventors and PLECs, cross-licensing and threat of countersuit are often insufficient for protecting a business from such assertions. Further, the risk of “royalty stacking”, wherein a business is forced to pay royalties to multiple patent holders, adds to the overall costs and risks of releasing such a product or service. Additionally, judges and juries have had a difficult time reaching a reasonable assessment of the economic benefit of infringed patents resulting in oftentimes unexpected and excessively large patent infringement damages awards. To the extent they are available, risk management products—such as those made by insurance companies—can be expensive and may offer insufficient coverage limits. Further, insurers have historically experienced difficulty in efficiently pricing such products, resulting in unacceptably high premiums or loss on the underwriting of policies.
Generally, a captive insurance company—also referred to herein simply a captive—is an insurance company that only insures all or part of the risks of its parent. In other words, it is an enterprise with all the authority to perform as an insurance company, but is organized by a parent company for the express purpose of providing the parent company's insurance. A captive or captive insurer is a risk management structure by which a business forms its own insurance company subsidiary to finance any losses.
Generally, captives are formed for various reasons. One reason is lower insurance costs. Commercial market insurance premiums must be adequate to meet the cost of claims, but consistent with other commercial enterprises. Insurers typically include in the premium an element to provide for their acquisition costs, overheads and profit. This portion of the premium can represent as much as 35% or 40% of the whole. In establishing a captive, the parent seeks to retain the profit within the group, rather than see it go to an outside party. A captive may also help reduce insurance costs by charging a premium that more accurately reflects the parent's actual loss experience.
Another reason to form a captive relates to cash flow. Apart from pure underwriting profit, insurers rely heavily on investment income. Premiums are typically paid in advance while claims are paid out over a longer period. Until claims become payable, the premium is available for investment. By utilizing a captive, premiums and investment income are retained within the group, and where the captive is domiciled offshore, that investment income may be untaxed. Additionally, the captive may be able to offer a more flexible premium payment plan thereby offering a direct cash flow advantage to the parent.
Risk retention is another reason captives are formed. A company's willingness to retain more of its own risk, particularly by increasing deductible levels, may be frustrated by the inadequate discount offered by insurers to take account of the increased deductible and by the fact that the company is unable to establish reserves to pay future claims. Establishment of a captive can help address both these problems.
Captives also address the unavailability of coverage. Where the commercial market is unable or unwilling to provide coverage for certain risks or where the price quoted is seen to be unreasonable, a captive may provide the coverage required.
A captive can also act as a focus for the risk management and risk financing activities of the parent organization. An effective risk management program may result in recognizable profits for the captive. Risk management can be viewed by a captive not as a cost centre, but as a potentially profitable part of the company's activities. A captive can also be used by a multinational company to set global deductible levels and enabling a local manager to insure with the captive at a level suitable to the size of their own business unit while the captive only buys reinsurance in excess of the level appropriate to the group as a whole.
Captives also enable access to the reinsurance market. Reinsurers are the international wholesalers of the insurance world. Operating on a lower cost structure than direct insurers, they are able to provide coverage at advantageous rates. By using a captive to access the reinsurance market the buyer can more easily determine their own retention levels and structure their program with greater flexibility.
Another reason captives may be formed is to write unrelated risks for profit. Apart from writing its parent's risks, a captive may operate as a separate profit centre by writing the risks of third parties. In particular, an organization may wish to sell insurance to existing customers of its core business. For example, retailers may sell an extended warranty to cover the risk being carried by the retailer's captive. The claims pattern of this type of business is usually very predictable with a large number of small exposures and provides the retailer with a valuable additional source of revenue.
Yet one more reason captives may be formed is tax minimization and deferral. Tax considerations in forming a captive depend on the domicile of both the parent and the captive. Integration of a captive as part of an overall tax planning strategy is a complex subject so that professional legal and tax advice may be helpful.
Currently, there are many types of captive insurers. Single-parent captives underwrite only the risks of related group companies. Diversified captives underwrite unrelated risks in addition to group business. Association captives underwrite the risks of members of an industry or trade association, such as liability risks of medical malpractice.
Agency captives are formed by insurance brokers or agents, which allow them to participate in the high-quality risks that they control.
Rent-a-captives are insurance companies that provide access to captive facilities without the user needing to capitalize their own captive. The user pays a fee for the use of the captive facilities and is usually required to provide some form of collateral so that the rent-a-captive is not at risk from any underwriting losses suffered by the user.
Another type of captive is Special Purpose Vehicles (“SPVs”). SPVs are used in risk securitization. They are reinsurance companies that issue reinsurance contracts to their parent and cede the risk to the capital markets by way of a bond issue.
Risk-Retention Groups (“RRGs”) are another type of captive, which are usually liability insurance companies owned by their members. Under the Liability Risk Retention Act (“LRRA”), RRGs must be domiciled in a state. Once licensed by its state of domicile, an RRG can insure members in all states. Because the LRRA is a federal law, it preempts state regulation, making it much easier for RRGs to operate nationally. As insurance companies, RRGs retain risk. These are excellent vehicles for medical malpractice insurance.
Captives may be established as direct-writing companies issuing policies to, and receiving premiums from, their insureds, but the insurance industry is generally highly regulated, and in many jurisdictions, certain risks may only be written by an admitted insurer. Usually, and particularly in the case of smaller captives, it is simpler for the captive to operate as a reinsurer accepting the risks of its parent, which have been insured by a licensed direct-writing company (a “fronting company”) and then ceded to the captive. The fronting company usually charges a fee for its services and may require a letter of credit to guarantee the captive's ability to pay claims.
In addition to some of the types of captives described above, captives can fall under different tax and regulatory regimes. Captives can be taxed as a U.S. company, or may choose to be taxed as a foreign company. Captives can be formed in several states in the U.S., or can choose from one of several competent offshore jurisdictions.
A demand therefore exists for a system and methods for, and through the use of, which the risk arising from the intellectual property rights owned by another or others can be better assessed and managed. The present invention satisfies the demand.